Stress-free

Well, the Sunday reaction to the European bank stress test results seems to have been one of relief. Like Rocky Balboa to Clubber Lang, analysts seem to be saying "You ain't so bad."

Although there were officially 24 failures, upon further review capital raising activities since the end of last year have enabled another 10-11 banks to meet the stress test criteria ex-post; what we're left with is a dog's breakfast of usual-suspect banks, largely from usual-suspect countries. Indeed, looking at a list of these institutions, Macro Man almost feels like listening to (insert wretched pop song of your choice from 3 years ago here), it feels so very 2011.

Regardless, if markets want to be relieved, they will start by taking the SX7E higher this morning. After the harrowing decline in the six weeks starting the beginning of September, it should make for relatively stress-free trading for longs in European financials and the periphery.

Or will it?

After all, Macro Man cannot help but recollect that the EBA published "good news" in prior stress test results. To be sure, this version is a bit more credible, coming with the imprimatur of the ECB's asset quality review; nevertheless, one might credibly question how and why institutions in, say, Germany did "surprisingly well."

Perhaps Macro Man's memory is failing him in his middle age, but he cannot recall those episodes ending particularly well. To be sure, there's a different sheriff in town now, and a lot of water has passed under the bridge. The ECB is revving up a QE program rather than hiking Europe back to the Stone Age.

Nevertheless, and bearing in mind that your author does not possess an intimate familiarity with the balance sheets of every constituent of the Eurostoxx banks index, history suggests that relief rallies on news like this are meant to be sold- particularly if you're long.

After all, the only truly stress-free position in European banks is to be flat!

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comments

The stress test's valuations seem to rest upon the rather tenuous myth that there is a market for all these things that the banks own. There may be a 1x1 for something which DB is long 1.2bn of, however, as you suggested, the exercise was done with an end goal in mind, therefore seems about as relevant as an Amish at a tech conference.

Anyway, on the Eurozone, banks etc. Well, this has become a sensitive issue here, but points of note;

1) Trailing growth is already very, very low. Unless you are convinced of an imminent relapse into 2008 or 2011 territory, this is EXACTLY what a near-recession amid low trend growth looks like in my view.

2) Macroeconomic surprise indices are depressed, and equity outflows at record highs indicating that the bone is pretty dry from the short side. September numbers from the German engine room will be very strong, France is growing as energy production is coming back, Spain is growing, and Italy, well poor Italy! Also, narrow money growth is accelerating(!) ... this is an alarmingly good leading indicator in the euro area. No need to complicate things here chaps. The ECB is printing ...

3) Banks are getting free funding in one end, and the ECB is underwriting/buying their products in the other end. With private QE in full swing and the ECB likely to do more, not less, the argument for a short here is, well, difficult (although I hasten to add, this is NOT what MM is advocating).

4) What is the contrarian high risk/reward trade here? I mean really ... long Dax/short bunds. Look at the stock-to-bond ratios; the oldest tool in the book but they are telling a very clear story here.

Disaster is possible, but betting on one at this point in the euro area is an accident waiting to happen in my view.

And remember, there is no possibility that I could be wrong, in any way ;)

LB has been avoiding the European bank argument but is currently long EURUSD for a trade. We do not anticipate anything hawkish from Dame Janet this week, so although POMO is over, zero rates are still with us, perhaps in perpetuity. The USD is in our view over-bought here, and 50% of DX is the despised Euro after all.

Last Thursday we bought EWZ calls, selling them into Friday's rocket launch around lunchtime. This morning we were back to the same trade as punters sold Brazil into the abyss. Just keeping busy while you guys debate the End of Europe.

RSX has got to the point where even oil plunges are barely moving the dial, nobody much left to sell. With two of the BRICs near 5 year lows, we might be setting up for a tradable low in the emerging markets. Do you fancy holding a 0.83% bund or having a punt on Gazprom yielding 6.2% or a utility like CIG that is probably going to be yielding 8-10%? [I know, I know, send the hate mail to the usual address.....]

Probably no rush on these tarnished beauties as they are likely to be a big part of the "all the toys out of the pram" sale that happens every December for tax purposes. Last year that fire sale delivered a Smörgåsbord of delicious yield at bargain prices (REIT preferreds and munis), so a big thank you to all those clueless mugs.

In other news, today saw the last POMO of modern times, until the inception of QE4, that is. Mr Market has Come Out of the closet and revealed that since 2009 he has been, on and off, a practicing POMOsexual, beginning with furtive one-on-one POMOsexual encounters with mortgage backed securities during QE1 and progressing to exchanges of liquidity with multiple counter-parties over risky assets in QE2 and culminating in what can only be described as Bacchanalian POMOsexual orgies in peripheral European debt during QE3.

The Pope has announced that although POMOsexuality remains against the teachings of the Church, POMOsexuals will no longer be excommunicated because "when you look around in the central banks, they are almost all at it..."

C Says,The V having come in most equity not involved in European core issues settled into the low volatility grind that oft follows the V. I think there will be enough Santa believers to keep that action in play for awhile which is why I see no rush to commit directionally right now.

C Says,Nico,Good ,may it long continue. Political stability can be considered a saleable service like any other has far as I concerned. Want to stop that then let those countries from which these funds flow become better at providing that service themselves.

Couple of days old, but worth a read... explains how the Bond markets could spike when CB's stop QE:http://www.bloomberg.com/news/2014-10-26/treasury-liquidity-squeeze-seen-in-dealer-who-shut-off-machine.html

We are getting quite close here to LB's favourite targets for this retracement, which are SPY 197-198, and IWM 112, both of which are more or less the 50 day averages. If we nail both of those tomorrow before the FOMC and drain a lot of volatility then we would be a bit nervous for Mr Market.

I thought this article by L.A. Little was quite thoughtful. It reflects a lot of my own Japan-influenced thoughts on QE, rates and the Fed's views on a stronger dollar (they don't want it, and will try jawboning and even do more QE to keep it down).

I was just thinking that a year or so ago, many commentators were thinking "Janet Yellen will have a tough time of it as rates rise and she will go down in history as the tough Fed Chair who ended QE and hiked rates", and I was smiling quietly at the time and thinking, a leopard doesn't change her spots. The BoJ has had many leaders since the beginning of ZIRP......

Nico,Rather curious, did you sell to rent? Current yields average 3% in London, which is at least 1% above financing cost (hsbc just announced a 1% mortgage), and with transaction costs at least 6-7%, you would need a drop of at least 10% in nominal terms (or more than that if it happens over many years) in order to break even. Are you calling a crash?